Money markets euro markets stable with no sign of rate cut

﻿* ECB keeps rates on hold, no discussion of easing* Analysts still expect one more cut* Markets not fully pricing low rates for a long timeBy Kirsten DonovanLONDON, Oct 4 Euro zone money markets were stable on Thursday after the European Central Bank kept interest rates on hold, giving no clue when, or if, it may ease them further, although many analysts still expect such a move. The ECB held its main refinancing rate at 0.75 percent and left the rate it pays banks to deposit cash over night - a key factor in calculating the rates at which cash is lent to the wider economy - at zero percent as expected. However, President Mario Draghi said rate cuts had not been discussed at all this month."It's looking less likely we'll get a cut next month," said Credit Agricole's global head of interest rate strategy David Keeble."We're not ruling out a cut, we expect it to come at some point, but they're dragging their feet."

The ECB can cut either the deposit rate or the refinancing rate or both. It has typically maintained a fixed corridor between the two rates but in order to continue this, any further refi rate cut would have to be accompanied by an unprecedented fall in the deposit rate to negative territory. Market pricing based on forward overnight swap rates and presuming a constant relationship between these and the deposit rate shows that the expectation of a cut in the deposit rate this year remains minimal."The deposit rate remains the underlying driver for short-term interest rates and the macro economic impact of changing the refi rate alone is not obvious," said RBS rate strategist Simon Peck. However, economists polled by Reuters last week expect the ECB to cut the refinancing rate to 0.5 percent in the fourth quarter of the year, then remain on hold through 2013.

"Looking at the global backdrop there still remains the justification at some point on the horizon for a rate cut," RBS' Peck said. "With the focus currently on the OMT programme this may turn into a story for early 2013," he added, referring to the ECB's Outright Monetary Transaction bond-buying programme. The Eonia overnight rate is currently at 8.5 basis points . It is seen at 7 basis points in December and only marginally lower through the first half of next year. If a deposit rate cut to minus 25 basis points were being priced in, forward Eonia would likely fall further. And without further changes to the ECB's remuneration system, having a negative deposit rate may not encourage banks to lend more: banks could continue to leave excess cash in their current accounts at the central bank - which pays no interest - rather than lend it to each other or the wider economy. An ECB survey released last week showed that conditions worsened in euro zone money markets in the second quarter of 2012 with liquidity and lending falling, while lending to the firms and households remains moribund .

LOWER FOR LONGER What markets may not be pricing in fully however, is for how long rates may stay at very low levels. Deutsche Bank notes that the front end of the euro yield curve is steeper than both its sterling and dollar counterparts, implying a "faster normalisation period". For example, Eurodollar futures show an implied rate at the end of 2014 around 20 basis points higher than currently, while the Euribor equivalent shows implied rates around 35 basis points higher. The bank recommends buying December 2014 Euribor contracts and selling equivalent maturity Eurodollar contracts to take advantage of any flattening in the Euribor curve as lower rates for longer are priced in. Similarly, RBS recommends betting that the one-year Eonia rate in one year's time will fall. That rate is currently at 18 basis points and the bank has a target of 8 basis points.